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Tickers in this Article: XOM, CVX, BP, APA
Oil prices tested $130 per barrel last Thursday, hitting monthly lows, while also breaching ascending support of the five-month trend. What does this mean for oil prices and oil stocks? The answer does not lie in one place, nor do the catalysts. The overall situation is quite complicated, but here's what's happening...

Oil Motivators
To get an idea of why the recent run in oil has been a such a lengthy affair, we need to step back and consider the overall supply side issue. This past spring, supply seemingly showed signs of sluggishness, as OPEC refused to increase production, while bombings from countries like Nigeria hindered flow to world markets.

There are also demand issues to consider. Looking back into time, in April of 2008, Jad Mouawad of the International Herald Tribune wrote, "At the same time, oil consumption keeps expanding at a faster clip than production. Demand is forecast to increase this year by 1.2 million barrels a day, to 87.2 million barrels a day." Oil at highs was written on the wall; now though, the same signals aren't quite as clear. (For more on oil supply and demand, check out Peak Oil: Problems And Possibilities.)

Future Oil Catalysts
In the near term, there are two events outstanding that could drive oil higher:

  • Iran - The United Nations has given Iran about two weeks to make a decision on accepting aid in exchange for halting uranium enrichment. Should Iran balk, the country (which incidentally is the fourth largest supplier of oil around the world) could see significant isolation as political tension heats up. This would likely be bullish for oil.

  • Hurricanes - The National Hurricane Center is presently indicating that the Tropical Storm Dolly is moving through the Gulf of Mexico toward Southern Texas. The NHC says there's a 29% chance that the storm could strengthen to an all out hurricane, which may then force the evacuation of offshore platforms and create a hiccup in supply.
Overall, supply is a touchy issue when considering oil. Should tension from Iran, or a hurricane ensue, oil could rocket again. Moreover, it's also important to note that supply factor could be hurt by further pipeline-oriented bombings in Nigeria (although right now a political truce is in place), a contraction in supply from Libya, or slowed production expansion from Saudi Arabia. The technicals are presently showing oil could be in for a continued pullback, but the long-term technicals still embody significant upside risk.

The Currency Factor
One additional area to consider, many Forex traders know oil is tightly tied to the U.S. dollar, because it is traded in the greenback worldwide. For every 1% the U.S. dollar declines, oil adds $4 in premium. However, the U.S. dollar could actually be on the eve of a reversal against the euro, simply based on the European Central Bank's hawkish rhetoric over the past year, and it's lack of willingness to ease interest rates. In the June 3 meeting, the ECB actually raised rates a quarter point to 4.25%, citing second round inflation potential as the motivator. The bottom line is the ECB's "might euro chutzpah" is doing nothing more than killing Euro Area GDP growth by artificially propping up the euro and clipping liquidity desperately needed at this time. (To learn the underlying theories behind these concepts, read The Importance Of Inflation And GDP.)

Here's the rub, the U.S. Dollar Index is composed of about 58% euro, and thus, the ECB's actions (while the FOMC has at the same time, lowered rates) are hurting GDP growth, which will eventually force rate cuts overseas. As the ECB is forced to tuck its tail between its legs and cut rates, the euro will decline and the U.S. dollar would strengthen. Because the euro makes up the majority of the U.S. Dollar Index, a bold rally in the greenback would ensue overall, and then... because oil is so tightly correlated to the U.S. dollar, crude could have trouble moving higher. Dig?

Of course, a war with Iran would likely nullify all of the aforementioned, but it is something to consider.

Bottom Line
When considering oil as an investment, it's hard to avoid big oil names like ExxonMobile (NYSE:XOM) and Chevron (NYSE:CVX). After all, these brutes are sitting on hordes of cash, $41 billion and $8.6 billion respectively. Exxon's dividend yield is presently 1.6%, while Chevron is paying 3%, which will likely keep Wall Street interested, regardless if oil dips in the near term.

Another stock to consider is BP (NYSE:BP). The company is currently sitting on $4.8 billion. This is less than the two aforementioned brutes, but it is hard to turn away from the 5.2% dividend yield.

It might be a good idea to avoid trading independent's like Apache Oil (NYSE:APA), as, without the same cash and dividend yields of the big guys, there could be more downside risk. However, with stocks like Apache - which is rock solid overall - the event just makes the company look more attractive for a buyout. This would would be good for investors. Overall, the outlook for oil stocks is bullish, but there could be more downside in the short-term.

For more on analyzing these investments, read Oil And Gas Industry Primer.

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